Finance

Duncan Mavin is a former Bloomberg Gadfly columnist.

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

Give John Cryan at least some credit. If nothing else, Deutsche Bank's new CEO should get a pat on the back for prompt communication.

Deutsche's Pain
Shares of the German bank are down almost 40 percent this year
Source: Bloomberg data

Since he took over last year, the bank has twice announced poor quarterly earnings ahead of schedule. On Monday, the bank reassured investors it can make coupon payments on some of its riskiest debt, bringing forward by a month a regular disclosure on the bank's capacity to pay investors.

This most recent move is aimed at stopping the bank's difficult-to-fathom equity story -- does the bank have a viable model to grow earnings? -- from infecting credit markets, which are more concerned about the bank's ability to honor its debts. Those concerns are partly specific to the bank and partly much, much broader.

First, the broad backdrop: Deutsche Bank and other banks across Europe have issued 91 billion euros ($102 billion) in so-called Additional Tier 1 capital since April 2013, urged on by regulators who want them to shore up their capital buffers.

Credit investors, starved of yield because of low interest rates globally, have lapped up the securities. The reason? They offer a slightly higher yield than regular bank debt, because coupon payments are optional. In reality, banks will do just about anything to meet their AT1 payments: missing a payment would send a message of panic to credit and equity investors alike.

In other words, investors bought AT1s because they perceived it offered more yield than regular bank debt with more or less the same risk of default. Now though, concerns about Europe's banks are gathering steam, and investors are repricing the risk of default.

Regulation is forcing banks to retrench from some previously lucrative businesses. Lacklustre economic growth and low interest rates are stymieing profit growth in other areas. Concerns about China's economy and the energy industry are rippling through markets, reducing activity among bank clients.

There are specific concerns about Deutsche Bank. Cryan is trying to reshape the business while facing these ominous economic and market headwinds. There's still a slew of litigation costs to be settled. And he's trying to offload parts of the bank that don't fit any more, including Postbank, the domestic German retail unit. The announced full-year net loss of 6.8 billion euros darkened the mood.

The bank's shares now trade at about 35 percent of the tangible book value of the bank's assets, partly because equity investors can't get a clear handle on what lies ahead.

Tangible Pain
Deutsche Bank trades at less than half tangible book value
Source: Bloomberg News. European Bank Average is based on STOXX Europe 600 Banks Index.

In the credit market, concerns were fueled Monday by a note from CreditSights analyst Simon Adamson that spelled out "a base case" for Deutsche Bank to pay AT1 coupons this year and next year. But there is a caveat -- a bigger than expected loss this financial year, because of a major fine or other litigation cost, could wipe out the bank's capacity to pay. In other words, what happens if a big unknown strikes? 

Deutsche Bank, for its part, made the case that it has more than enough capacity for the 2016 payment due in April -- 1 billion euros of capacity compared with coupons of about 350 million euros. The bank says it estimates it has 4.3 billion euros of capacity for the April 2017 payment, partly driven by the proceeds from selling its stake in a Chinese lender. That sale is still pending regulatory approval but should go through in coming months.

So, Deutsche Bank ought to have enough to make its payments and will be desperate to do so. Can pay, will pay. Unless, the bank is hit with a big shock, like a major, unforeseen litigation cost. Nervous investors await further communication.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Duncan Mavin in London at dmavin@bloomberg.net
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net